Hong Kong Monetary Authority has sounded another warning about the risk of runaway home prices to the economy. Photo: Sam Tsang

The Hong Kong Monetary Authority has sounded another warning about the risk of runaway home prices to the economy, which also faces a poor short-term outlook because of weak foreign demand.

In its latest quarterly report on the health of the city's economy and the banking sector, the authority said the city could be thrown back into recession if the European sovereign debt crisis escalated and if the United States failed to moderate tax increase and government spending cuts due to take effect next month.

On the domestic front, the authority said the disconnect between housing prices and economic fundamentals had become more acute, citing a 23.2 per cent increase in home prices in the 12 months to October while economic growth was forecast by the government to be only 1.2 per cent this year.

It said the overheating property market - fuelled by protracted negative real interest rates (the result of near-zero nominal interest rates and high inflation) - could pose a risk to homebuyers' future ability to service their mortgages, if they were forced to borrow too much compared with their income.

"The extremely low interest rate environment also means the mortgage burden could rise substantially in the future and put mortgagors in distress when the interest rate returns to a more normal level," the authority said.

The HKMA has repeatedly warned of this risk in the past year and has tightened caps on bank lending to homebuyers as property prices soared.

The banking sector had performed well despite the unfavourable economic environment overseas, the authority said.

In the year's first nine months, the combined pre-tax operating profit of retail banks rose 13.9 per cent year on year.

Their net interest margin remained stable in the third quarter at 1.4 per cent, the highest level since the second quarter of last year.

The fraction of retail banks' loans with a risk of delinquency in repayment fell to 0.5 per cent at the end of September from 0.52 per cent at end-June.

The capital adequacy ratio - a measure of banks' ability to withstand economic shocks - rose to 16.1 per cent in September from 15.9 per cent three months earlier, well above the international minimum standard of 8 per cent.

This article appeared in the South China Morning Post print edition as HKMA warns of risk from soaring property prices